What Is Bankruptcy and What Happens After You File for It?
Nearly everyone will need to borrow money at some point in their life, whether it’s to pay for college, buy a house, or just use a credit card to pay for a dinner out. And nearly everyone who borrows expects to be able to pay it back. But sometimes life takes an unexpected turn, and you may find yourself in a position of not being able to pay what you owe. If you have more debt than you can pay, filing for bankruptcy may help you get a fresh start — but there are long-term consequences. Here’s what you need to know.
What Is Bankruptcy?
Bankruptcy is a legal proceeding that helps businesses and consumers get rid of their debt and repay their creditors. There are two basic kinds of bankruptcy: liquidation, in which your possessions are sold off to pay your debts, and reorganization, in which your debt is restructured to enable you to pay part or all of it off.
The two most common types of bankruptcies for individuals are Chapter 7 and Chapter 13. Chapter 11 is the most common type for businesses, and you’ll often hear of a company “filing for Chapter 11.”
What Is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is a liquidation proceeding, so your property may be sold to pay your debts. Unsecured debt, such as credit cards, is wiped out in a Chapter 7 proceeding. Some kinds of debt, like back taxes, child support and alimony, cannot be eliminated in a Chapter 7 bankruptcy.
When you file for Chapter 7 bankruptcy, your nonexempt assets are sold, and the money is used to pay your creditors and lenders. Nonexempt assets include cash, investments, a second car or home, collectibles and so on. You can keep your exempt assets, which include your house, your car and some personal property. Some assets are named as being exempt by federal law, and others may be included depending on your state. Your remaining unsecured debts are then discharged, and you can start over.
In order to file for Chapter 7 bankruptcy, you must not make enough money to be eligible to file for Chapter 13 bankruptcy.
What Is Chapter 13 Bankruptcy?
Chapter 13 bankruptcy is for those who have a reliable source of income, such as income from a job, but do not make enough money to be able to pay off their debts as agreed. Chapter 13 bankruptcy is a reorganization proceeding, so your debts will need to be restructured in such a way that you can pay them off within three to five years.
If you have less than $419,275 in unsecured debt and less than $1,257,850 in secured debt, you may be eligible to file for Chapter 13 bankruptcy. If you do, you will need to work with the court to come up with a repayment plan that repays some debts in full, including child support, tax debts and liens, and secured debts like mortgages, and some debts to unsecured creditors. You must be able to show that you have sufficient income to comply with the terms of the repayment plan and still pay your other living expenses.
What Happens After You File for Bankruptcy?
A bankruptcy filing is really only the beginning of the process. Here’s what happens next:
- A trustee will be assigned to your bankruptcy case. They will oversee the liquidation of assets, in the case of a Chapter 7 bankruptcy, or the repayment of debts in the case of a Chapter 13 proceeding.
- You will go to a 341 meeting of creditors. Creditors can attend, but they usually don’t. You’ll be asked about your debts and your assets, under oath.
- Debt collection procedures will be stopped. This is called an automatic stay.
- You will take a course on financial management to help you better manage debt in the future. This is a requirement to get your debt discharged.
- Some of your property may be sold (Chapter 7) or you may begin a repayment plan (Chapter 13).
- Your debts will be discharged.
A bankruptcy will decrease your credit score and will remain on your credit report for seven years if you file for Chapter 13 and 10 years if you file for Chapter 7. It will be harder — and more costly — to get a car loan or mortgage if you have filed for bankruptcy. But if you adhere to your repayment plan and keep up with your other debt obligations, it’s possible to come out of bankruptcy with a clean slate.
Filing for bankruptcy can be a way out for those who have gotten into unmanageable debt, but it should not be entered into lightly. It can have a long-term impact on your credit score and your ability to borrow in the future. It’s important to only take on debt that you will be able to manage and only consider bankruptcy as a last resort.
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- FindLaw. "Chapter 7 Bankruptcy."
- FindLaw. 2021. "What Happens After Bankruptcy?"
- Judicial Conference of the United States. "Revision of Certain Dollar Amounts in the Bankruptcy Code Prescribed Under Section 104(a) of the Code."